Strategy Number 10 – Long “Strangle”

Expectation of especially high level of volatility of the DJ Index. This strategy is similar to the “Straddle” strategy, but profits are obtained only at a higher level of volatility.

For the purpose of example, we will assume that a war is expected in the next two months (which will result in very sharp fall in the DJ Index), while at the same time there an identical chance of a peace treaty being signed (which will result in sharp increase in the DJ Index).

Strategy components

Buying a Long Call option outside-the-money (at a strike price which is higher than the DJ Index).

Buying a Long Put option outside-the-money (at a strike price which is lower than the DJ Index).

For example: Buying a Long Call 120 option at a price of $500, and buying a Long Put 80 option at a price of $500.

Expenses / Income from building the strategy

Expenditure of $1,000.

Strategy graph:

Auxiliary table for building the profit line

DJ Index(Horizontal axis)

(Fixed expenses)/ fixed income

Variable income(Call contribution)

Variable income(Putl contribution)

Total profit / (loss) (Vertical axis)2+3+4

1

2

3

4

5

50

($1,000)

—

$3,000

$2,000

60

($1,000)

—

$2,000

$1,000

70

($1,000)

—

$1,000

$0

80

($1,000)

—

—

($1,000)

90

($1,000)

—

—

($1,000)

100

($1,000)

—

—

($1,000)

110

($1,000)

—

—

($1,000)

120

($1,000)

—

—

($1,000)

130

($1,000)

$3,000

—

$0

140

($1,000)

$2,000

—

$1,000

150

($1,000)

$3,000

—

$2,000

Strategy analysis:

Source of profit

We profit on a sharp change in the DJ Index. When the index goes up we gain on the Long Call. When the index goes down we gain on the Long Put.

Source of loss

Cost of building the strategy. The loss is maximized when the DJ Index moves in narrow range, and is limited to the cost of purchasing the options.

Break-even point

When the profit from the Call option or from the Put option equals the cost of the strategy totaling $1,000. This occurs when the index is at 130 points or 70 points.